401k Plan Design Basics Enhance Outcomes
401k Plan design basics need to be addressed for all 401k Plans. Rather than rely on financial wellness programs, plan sponsors and recordkeepers should go back to basics and focus on plan design — specifically, auto-enrollment and target date funds (TDFs) — instead.
InvestmentNews, recently spotlighted these findings from its Retirement Plan Adviser Recordkeeper Think Tank in New York. It’s widely believed that automatically enrolling employees into employer-sponsored retirement plans and defaulting them into target date fund investments – helping them to achieve proper asset allocation – are plan design best practices. However, as InvestmentNews aptly pointed out, few plans use automatic enrollment in their plan design, and many plan participants misuse TDFs, creating a deficit in their savings. Unfortunately, rather than addressing these issues, recordkeepers have chosen instead, to roll out financial wellness programs, which aren’t widely used, thus failing to help participants who need a nudge.
Automatic enrollment is a beneficial plan design feature. According to InvestmentNews, automatic enrollment uses retirement savers’ inertia to the advantage of plan participants. Data from Vanguard shows that plans with automatic enrollment as part of their plan design have 52% higher participation rates than those with voluntary enrollment. Since plan participation is a marker of a retirement plan’s success, it’s no wonder that 401(k) plan sponsors’ uptake of automatic enrollment in their plan design has increased 55% in the past decade, according to the Plan Sponsor Council of America, cited by InvestmentNews. Nonetheless, just 61% of 401(k) plans have adopted automatic enrollment as part of their plan design, and mostly for new hires rather than all employees. In addition, more large than small plans use automatic enrollment in their plan design. According to the PSCA, again cited in InvestmentNews, 70% of plans with at least 5,000 participants use auto-enrollment in their plan design, whereas only 27% of plans with fewer than 50 participants do.
Unfortunately, many target date fund investors are mis-using them, potentially diminishing their savings as a result. According to recordkeeper Alight Solutions, as quoted in InvestmentNews, one in 10 target date fund investors is invested in more than one TDF in their workplace retirement plan. Vanguard data also show that more than 30% of participants use more than one TDF, or they use a TDF along with other funds in the plan. This approach could prove to be a detriment to their investment returns, as TDFs are designed to be a stand-alone investment vehicle. The use of additional funds skews a participants’ asset allocation. That’s concerning, as asset allocation is responsible for 90% of the variability of long-term investment returns, according to a 2017 Vanguard study. That investors are mis-using TDFs is troubling given their widespread popularity. According to Cerulli Associates, TDFs currently capture around 58% of retirement plan participant contributions. Cerulli projects that figure will hit more than 80% by 2023.
According to InvestmentNews, recordkeepers and advisors have some ideas to address these plain design conundrums. Recordkeepers could:
- Sell 401(k) plans with auto-enrollment as a default feature;
- Give plan sponsors a price break to implement an auto-enrollment feature in their plan design; and
- Disallow TDF investors from contributing to more than one fund, or re-enroll participants into a TDF annually to correct participants who are allocated incorrectly.
However, some plan sponsors will choose to avoid annually re-enrolling participants in TDFs, according to InvestmentNews.
While recordkeeper offerings seem to be focused on 401k plan design “bells and whistles” such as financial wellness and student loan repayment assistance, these aren’t being as widely used by participants who could benefit. As such, a return to plan design basics, such as automatic enrollment and encouraging participants to invest in a single target date fund, may be worth plan sponsors’ attention to help maximize retirement readiness going forward.